The measure

Higher rate income tax relief is being restricted for contributions by or on behalf of individuals to UK registered pension schemes and qualifying overseas pension schemes. Higher rate relief will be tapered away for those with taxable incomes (as adjusted) of between £150,000 and £180,000 from 6 April 2011 so that for those with incomes above £180,000 contributions will only benefit from basic rate tax relief. The exact mechanism for applying these rules has not yet been decided.

Provisions applying from 22 April 2009 will prevent the forestalling of the new rules. For the tax years 2009/10 and 2010/11 individuals with incomes of at least £150,000 in the year, or any of the preceding two tax years could be affected. Steps taken to reduce income below £150,000, for example by entering into salary sacrifice arrangements set up after 22 April 2009, will be negated by adding back the amount sacrificed.

There will be a special annual allowance of £20,000. This will be applied to any pension savings that exceed the individual's normal established pattern of contributions. Contributions in excess of this level will be taxed at 20% for 2009/10 and will be collected via self-assessment. From 2010/11, when the 50% top income tax rate takes effect, indications are that this special allowance charge may increase to 30%. Enhanced protection does not prevent this charge arising.

The special annual allowance is eaten up first by any protected pension savings (ie normal ongoing regular pension savings) and any one-off amounts paid between 6 April 2009 and 22 April 2009.

The special annual allowance charge applies in addition to the normal annual allowance charge that was introduced from 6 April 2006 (£245,000 for 2009/10). However where both the normal annual allowance and the special annual allowance are both exceeded the amount subject to the special allowance charge is reduced by the normal annual allowance excess.

It may be possible to claim a refund of contributions paid on or after 6 April 2009 to prevent the special annual allowance from applying. However any refund will be subject to a 40% tax charge, payable by the scheme administrator.

Who will be affected?

From 6 April 2009: individuals with adjusted income of at least £150,000 in either the current or any of the previous two tax years.

In each case the new rules will only apply to those who change their normal pattern of pension saving and whose total pension savings exceed £20,000 per year.

For money purchase arrangements a regular pattern of contributions include those made on a normal basis at least quarterly and for defined benefit arrangements they include any increases in accordance with the scheme rules in effect on 22 April 2009. One-off contributions made, for example, once a year, are not regarded as normal ongoing regular contributions and are therefore likely to be subject to the special annual allowance charge.

The changes have no impact on corporation relief for employer pension contributions.

When?

The main change comes into effect from 6 April 2011, but rules apply from 22 April 2009 to prevent individuals taking advantage of the deferral.

Our view

This represents yet another nail in the coffin of pensions tax simplification. A mere three years after the introduction of the new regime, employers, individuals and the pensions industry have another set of complexities to grapple with. It is inevitable that the administrative costs of running a pension scheme are going to remain high for a further period of time before these new rules bed down.

Whilst the restriction of higher rate relief is billed as coming into effect on 6 April 2011, the forestalling rules have immediate effect.

The ability to save toward pensions when individuals can afford to do so, rather than being tied to regular contributions, is potentially severely hampered by the new proposals, given that only 'normal, regular ongoing pension savings' are protected from the new special annual allowance. This flexibility has been important ever since so called 'carry back/carry forward relief' was withdrawn and potentially adversely affects the self employed and employees that make a significant part of their pension savings once a year from bonuses, instead of or in addition to salary.

We urge caution to employees considering 'waiving bonuses into pensions'. Until now, this has been a highly efficient way of increasing pension savings, attracting relief from employee and employer National Insurance Contributions (NIC). However, whilst such a pension contribution made on or after 22 April 2009 might save employee NIC at 1% (1.5% from 2010/11) and employer NIC at 12.8% (13.3% from 2010/11), if it is caught by the new forestalling rules, it would be subject to the new tax charge at 20%. Whilst employers will still save NIC, employees will clearly be significantly worse off overall.

Another potential inequity relates to the way in which the forestalling rules look back to earnings arising since 2007/08.

Taxpayers in the 40% tax band after 2010/11 will be breathing a sigh of relief as they will continue to get relief at 40% on their contributions, or 60% if their Personal Allowance is being phased out.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.